Have International Financial Reporting Standards (Ifrs) Improved Financial Reporting Quality

Executive Summary

International Financial Reporting Standards (IFRS) represents a major regulatory element in accounting globally. Most firms have adopted IFRS- partly as a result of a push by national governments- because they believe it will increase the quality of their financial reporting, thereby improving accountability and leading to increased profits.

Australia is one of the very earliest countries that adopted IFRS and pushed to have its firms adopt the framework in their financial reporting. The purpose of this paper is to examine the feasibility of IFRS in achieving the purpose for which it was adopted in the country. In this regard, this paper will cite evidence showing how IFRS has improved the quality of financial reporting in other countries and in Australian firms (both public and private) that have adopted mandatory IFRS.

Introduction

From 2005, more and more countries have moved towards implementing the elements of International Financial Reporting Standards (IFRS). By 2008, more than 100 countries had adopted IFRS reporting or reported requiring this framework in the future, including the US Securities and Exchange Commission (SEC), which at the time was considering allowing firms in the country to prepare their financial statement based on the IFRS framework (Goodwin et al 2007; Daske et al 2008). Australia is one of the countries that have since adopted IFRS. In fact, as noted above, it was one of the earliest countries to adopt IFRS.

However, even as IFRS becomes increasingly prominent globally, many are questioning its credibility, whether it really does improve the quality of financial reporting. This question has been answered in various ways, with focus on various elements involved in accounting, including the actual quality of accounting (Barth et al 2008) and the information environment: i.e. a framework of accountability (Horton et al 2013). Other studies have cited evidence from national and local government entities and others on individual firms (Daske et al 2008; Ahmed & Alam 2012). Generally, the proponents of IFRS argue that it can facilitate cross-border comparability, increase transparency of reporting, and reduce costs of information and information asymmetry and, ultimately, “increase the liquidity, competitiveness, and efficiency of markets” (Horton et al 2013, 388).

This paper examines the evidence to provide a justification for the adoption of IFRS in Australia.

IFRS in Australia

The general question here regards the feasibility of the accounting standards in ensuring quality accounting. Barth et al (2008), for example, in their review of International Accounting Standards (IAS) (the predecessor to IFRS), found that the “accounting amounts of firms that applied IAS were of higher quality than those of non-US firms that did not” (p.496). This owed to an interaction of various elements of the financial reporting system, including the interpretation, enforcement and litigation of accounting standards”. However, it is important to note that the behavior of these three factors depend on the context (such as a country). As Horton et al (2012) note, the effects of compliance with IFRS are not homogenous for all firms or all countries. In other words, IFRS’s success elsewhere does not necessarily mean it will be a success in Australia. Moreover, Barth et al (2008) cited limitations of IAS relating to managerial discretion and inherent flexibility, which might also affect apply in the case of IFRS.

However, it is only fair to question IFRS. Besides, IFRS has been seen as an improved version of the earlier international standards of financial reporting and accounting.

Daske et al (2008) focus on general economic impacts of IFRS around the world and note that IFRS improves financial reporting by enhancing the ability to compare financial statements and improve corporate transparency.

Horton et al (2013) examine the ways in which IFRS has improved the information environment relating to financial reporting. It is important to mention in passing that studies have associated higher reporting quality with adverse selection in security markets and improved efficiency of information intermediaries (Hail & Leuz 2006; Hodgdon et al 2008). In the end, Horton et al (2013) base their examination on the hypothesis that the adoption of mandatory IFRS provides information quality results and, ultimately, affects the accuracy of analyst earnings forecast. Indeed, their findings show that, of the firms involved in their studies, those that had adopted mandatory IFRS had recorded significant improvement of the information environment and forecast accuracy. This view was reaffirmed by the finding that “the larger the difference between IFRS earnings and local GAAP earnings the larger the improvement in the information environment” (Horton et al 2013, 419).

Although Horton et al (2013) take note of limitations, such as the aforementioned issue of contextual differences between firms and countries, they show that these positive effects of IFRS on the information environment are more evident in capital markets, which they define as a situation that “facilitates efficient allocation of resources towards its most productive users” (419), a description that fits Australia. Supporting this view related to capital markets, Daske et al (2008) argue that IFRS in these markets reduces the amount of discretion in reporting by compelling firms to improve their financial reporting.

Ahmed and Alan (2012), on their part, focus on the effects of adopting IFRS on the financial reports of local government entities in Australia. In this regard, their study focuses on the effects of IFRS adoption on local governments’ accounting loss or surplus, equity and assets and liabilities.

Amplifying the findings of Horton et al (2013), Ahmed and Alan (2012) find a general positive effect on surplus and equity for large councils. Moreover, the increase on total assets exceeded that of total liabilities ($55 million and 3.07 million respectively). These findings shed light on the effects of IFRS on performance in general, which is positive.

Conclusion

This paper aimed to provide the evidence that IFRS is a good thing for Australia. It is, however, crucial to point out, as implied throughout the discussion, that the advantages of IFRS are not automatic. The market circumstances within a country, most importantly the type of economy, as well as internal contextual elements of adopting firms, play a major role in the success of IFRS. For example, while there is the view that IFRS have more positive impact in capital markets, they must however be accompanied by, for instance, strong government incentives for transparency (Hail & Leuz 2006; Hodgdon et al. 2008; Horton et al. 2013).

Having said that, this paper cites a number of studies that provide evidence regarding the positive impact of IFRS, not only in other countries but also within Australia, and in both private and public entities. Indeed, the complexity of the issue still remains and not all positive financial reporting elements in the countries adopting IFRS can be solely attributed to IFRS. Still, evidence ultimately shows that IFRS improve the quality of financial reporting in relation to the financial environment and preparation of actual financial documents (Ahmed & Alan 2012; Horton et al. 2013). 

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